Definition
A Certificate of Deposit (CD) is a negotiable financial instrument issued by a bank in return for a term deposit. Typically lasting up to five years, a CD offers competitive interest rates to attract larger investors. Originating in the USA in the 1960s, sterling CDs were introduced by UK banks in 1968 to draw funds away from clearing banks and attract them to merchant banks.
Examples
Short-term CD: An individual invests £20,000 in a 6-month CD yielding an annual interest rate of 1.5%. After six months, the interest earned would be £150.
Long-term CD: A corporate entity places £50,000 in a 5-year CD with an annual interest rate of 3%. Over five years, the total interest accumulated would be £7,500.
Subdivided CD: An investor holds a £50,000 CD but negotiates to sell part holdings of £10,000 each in the secondary market.
Frequently Asked Questions (FAQ)
Q: What is the primary advantage of a CD? A: CDs offer higher interest rates compared to regular savings accounts, making them an attractive option for risk-averse investors seeking stable returns.
Q: Can the money in a CD be accessed before maturity? A: Early withdrawal from a CD typically incurs a penalty which might include a forfeiture of a portion of the accrued interest.
Q: Is the interest earned on a CD taxable? A: Yes, the interest earned from CDs is subject to federal, state, and local taxes depending on the jurisdiction.
Q: Can CDs be sold before maturity? A: Yes, CDs can be sold in a secondary market. The sale price depends on prevailing interest rates and demand for such securities.
Q: What differentiates a CD from a savings bond? A: While both are low-risk investments, CDs offer fixed interest rates and specified terms, whereas savings bonds may offer variable rates and longer holding periods.
Related Terms
- Merchant Bank: A financial institution engaged in investment activities, including issuing and trading CDs.
- Clearing Bank: A bank that processes checks and money transfers between different banks.
- Secondary Market: A market where investors buy and sell securities like CDs after the original issue.
- Discount House: A financial institution specializing in dealing short-term government and high-quality corporate debt securities.
Online References
- Investopedia on Certificates of Deposit
- Federal Deposit Insurance Corporation (FDIC) – Consumer CD Information
Suggested Books for Further Studies
- The Banking System by Marie T. Romain
- Money Market and Capital Market by Gleitzman & Gerson
- Understanding Financial Statements by Aileen M. Ormiston
Accounting Basics: “Certificate of Deposit” Fundamentals Quiz
Thank you for exploring the intricate details of Certificates of Deposit. Your rigorous effort in mastering these essential financial instruments reflects a commendable pursuit of financial excellence!